FOCUS POINT

Amidst the recent global challenges and trade-wars,
many developing countries (including India) faced
macroeconomic issues due to weakness in their currency.
The Indian Government has taken many steps to protect
the devaluation of its currency by carrying out open market
operations in currency markets, boosting exports, putting
in place additional import duties, etc. India has taken yet
another step in boosting its foreign reserves by liberalizing
the foreign currency loan regime. There was also a constant
pressure and expectation from the Reserve Bank of India
(RBI) to reduce the interest/borrowing costs.

External Commercial Borrowings (ECB) regime provides
for a framework for the Indian corporates to avail foreign
currency loans from an overseas lender.

Over the years, the ECB regime has undergone significant changes, however
they are still perceived to be stringent and with many
restrictions. Accordingly, the RBI, vide A.P. (DIR Series)
Circular No. 17 dated 16 January 2019, has revised the
extant ECB framework, which signifies a major change in
the policy of the Indian Government. The new framework is
instrument neutral and would further strengthen the Anti-
Money Laundering/Combating Financing of Terrorism
(AML/CFT) framework.

Below is a comparative analysis of the key changes:

Particulars

Existing Regulations

Revised Regulations

Definition of Indian Entity

Means a company or a corporate body or a firm in India.

Definition has been expanded to include Limited Liability Partnerships (LLPs).

Impact

This was one of the negative aspects for LLP, which is now rectified, and would
be a big boost for LLP as a viable entity option for foreign investors.

Impact

This would imply that service, trading
entities, etc., would also now be
allowed to avail the ECB facility. This is
a significant change and would resolve
issues of funding for these service and
trading companies, which hitherto
had relied only on Equity capital from
parent companies for their fund
requirements.

Start-ups can raise USD 3 million or
equivalent (newly included in a list of
eligible borrowers).

Impact

RBI has always been conservative
when it comes to capital account
transactions. This liberalization would
allow Indian corporates to fund their
operations by availing ECBs, which
could also provide interest arbitrage.

Late submission fees

No delay was allowed per se. In case of
any delay, the only option is going for
compounding, which is a tedious process
at times.

Late submission fee regime has been
introduced for the delay in reporting
requirements in the range of INR 5,000
or INR 50,000 or INR 100,000 per year
depending on the period of delay.

1. Start-ups are entities, which satisfies the conditions laid down in
Notification No. G.S.R 180(E) dated 17 February 2016, as amended/updated
from time to time

With liberalization of ECB regime, it is expected that many
companies may wish to avail its fund requirements through
ECB and would have an increase in the debt component.
Higher debt component is an age-old tax planning aspect
since interest on debt is a tax deductible item as compared to dividends, which are not tax deductible and attract
additional 20% dividend distribution tax.

However, one
must consider the following tax aspects before deciding on
an appropriate debt-equity mix.

Interest limiting deduction – Section 94B of the Indian Income Tax Act, 1961

Section 94B of Indian ITA restricts deduction in respect of
expenditure by interest (or of similar nature) paid to the
non-resident associated entities to 30% of EBITDA (Earnings
Before Interest, Taxes, Depreciation and Amortization).
The provisions do not apply to a banking company and for
others the threshold limit is INR 10 million. Furthermore,
the interest over the 30% limit can be carried forward for
set-off up to eight subsequent years.

The above provision was introduced from FY 2017-18 in line
with Action Plan 4 of OECD’s Base Erosion & Profit Shifting
(BEPS) project.

Indian corporates availing foreign currency loans from
related parties should also be mindful of these provisions
and properly plan their debt-equity structure so that there is
no disallowance of excess interest.

Foreign Lender - Taxability in India and Withholding Tax

The interest paid on foreign currency borrowing would be
liable to a reduced tax rate of 5% (plus applicable surcharge
and education cess) as per the provisions of Section 194LC
of the Indian ITA if the loans were raised prior to 1 July
2020. With these liberalizations in ECB, it is expected that
the government may extend the time limit of 2020 to boost foreign inflows.

However, it would be advisable for
companies to ensure that their ECBs/borrowings are done
before the above date to enjoy the 5% tax rate. Since the
tax rate is 5%, the Indian company paying interest must
withhold tax also @ 5% (plus applicable surcharge and
education cess).

Transfer Pricing – Interest rate to be at arm’s length

ECB regulations provide for maximum interest that can be
charged on ECB. Currently, the limits provided under the
ECB framework are benchmark rate plus 450 bps spread.
Benchmark rate in case of foreign currency refers to a
six-month LIBOR rate of applicable borrowing currency,
and for rupee loans, it refers to the prevailing rate of the
Government of India securities.

While the maximum ceiling is provided under the ECB
regulations, the interest rate for related party loans must
comply with the arm’s length interest rate from the transfer
pricing perspective. Accordingly, corporates are advised
to perform an interest rate benchmarking study to save
themselves from protracted litigation with Indian tax
authorities.

SKP COMMENTS

Most of the developed countries do not have any exchange
control regulations, and India has always spoken about
moving towards capital account convertibility. This
liberalization can be considered as one of the significant
move towards that. The revamped regulations are certainly
a welcome move as it provides a larger platform for Indian
Corporates to have access to global funding.

The revised framework has made certain pragmatic changes allowing trading companies and service companies to raise foreign funds. These would overall increase
the attractiveness of India as an investment destination
and go a long way in improving India’s ranking in ease of
doing business index. Furthermore, the introduction of late
fees for the delay in reporting is a welcome approach as it
obviates unwarranted compounding mechanism.

Also, the foreign equity holder or companies would be in a better
position to structure funding of their subsidiaries in a
flexible manner. Nonetheless, it would have been better if
the definition of foreign equity holder was streamlined to
include interest in an LLP.

Corporates have been presented with a unique proposition
to relook at their current funding structure, and debt-equity
mix, and accordingly plan their activities to take maximum
benefits of the above-mentioned liberalized framework.
This must be planned holistically considering other tax and
commercial aspects discussed above.